Macroecon Exam 2 Review

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National income accounting

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consists of concepts that enable those who use them to measure the economy’s output, to compare it with past outputs, to explain its size and the reasons for changes in its size, and to formulate policies designed to increase it.

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Gross domestic product

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The market value of all final goods and services produced in the domestic economy during the year is measured by the

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final goods

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consumption goods, capital goods, and services purchased by final users and that will not be resold or processed further during the current year

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intermediate goods

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ones that are purchased for resale or further processing

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value added

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the market value of a firm’s output minus the value of the inputs the firm bought from others to produce the output.

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expenditures approach

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requires the summation of the total amounts of the four types of spending for final goods and services.

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Personal consumption expenditures (C)

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the expenditures of households for durable goods and nondurable goods and for services

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Gross private domestic investment (Ig)

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the sum of the spending by business firms for machinery, equipment, and tools; spending by firms and households for new construction (buildings); and the changes in the inventories of business firms.

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Government purchases (G)

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the expenditures made by all levels of governments (federal, state, and local) for final goods from businesses, and for the direct purchases of resources, including labor

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Net exports (Xn)

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calculated as the difference between exports (X) and imports (M)

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income approach

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requires adding the income derived from the production and sales of final goods and services

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Taxes on production and imports

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are added because they are initially income for households that later gets paid to government in the form of taxes. This category includes general sales taxes, excise taxes, business property taxes, license fees, and custom duties.

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consumption of fixed capital

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is added to national income to get to GDP because it is a cost of production that does not add to anyone’s income. It covers depreciation of private capital goods and publicly owned capital goods such as roads or bridges.

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Net domestic product (NDP)

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the annual output of final goods and services over and above the privately and publicly owned capital goods worn out during the year. It is equal to the GDP minus depreciation (consumption of fixed capital).

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National income (NI)

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the total income earned by U.S. owners of land and capital and by the U.S. suppliers of labor and entrepreneurial ability during the year plus taxes on production and imports. It equals NDP minus a statistical discrepancy and plus net foreign factor income

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Personal income (PI)

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the total income received—whether it is earned or unearned—by the households of the economy before the payment of personal taxes. It is found by taking national income and adding transfer payments, and then subtracting taxes on production and imports, Social Security contributions, corporate income taxes, and undistributed corporate profits.

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Disposable income (DI)

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is the total income available to households after the payment of personal taxes. It is calculated by taking personal income and then subtracting personal taxes. It is also equal to personal consumption expenditures plus personal saving.

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Nominal GDP

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the total output of final goods and services produced by an economy in one year multiplied by the market prices when they were produced. Prices, however, change each year

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price index

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a ratio of the price of a market basket in a given year to the price of the same market basket in a base year, with the ratio multiplied by 100

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business cycle

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alternating periods of prosperity and recession even if the long-term trends show economic growth

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parts of the business cycle

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peak, recession, trough, and expansion to another peak

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peak

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the maximum level of real output at the start of the cycle

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recession

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which is a period of decline in real output that lasts six months or longer

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trough

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low point is followed by expansion

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expansion

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recovery in which the economy experiences an increase in real output

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unemployment rate

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calculated by dividing the number of persons in the labor force who are unemployed by the total number of persons in the labor force

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discouraged

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_______workers who have left the labor force are not counted as unemployed

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Frictional unemployment

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due to workers with marketable skills searching for new jobs or waiting to take new jobs. This type of unemployment is short-term, inevitable, and also generally desirable because it allows people to find more optimal employment

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Structural unemployment

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due to the changes in technology and in the types of goods and services consumers wish to buy

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Cyclical unemployment

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arises from a decline in total spending in the economy that pushes an economy into an economic downturn or recession

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full-employment unemployment rate or the natural rate of unemployment (NRU)

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the sum of frictional and structural unemployment and is achieved when cyclical unemployment is zero (the real output of the economy is equal to its potential output)

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NRU

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the unemployment rate that is consistent with full employment. It is not, however, automatically achieved and changes over time.

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GDP gap

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measure of economic cost

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Okun's law

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predicts that for every 1 percent the actual unemployment rate exceeds the natural rate of unemployment, there is a negative GDP gap of about 2 percent.

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inflation

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an increase in the general level of prices in the economy. During any period, the prices of products can rise, fall, or stay the same.

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Consumer Price Index (CPI)

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The primary measure of inflation in the United States

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deflation

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decline in the price level

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The rule of 70

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can be used to calculate the number of years it will take for the price level to double at any given rate of inflation

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Demand-pull inflation

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the result of excess total spending in the economy, or “too much spending chasing too few goods.” With this inflation, increasing demand is pulling up the price level

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Cost-push inflation

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the result of factors that raise per-unit production costs

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per-unit production costs

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average cost is found by dividing the total cost of the resource inputs by the amount of output produced

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core inflation

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emoves from the inflation rate calculation the often temporary and volatile swings in food and energy prices

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Real income

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determined by dividing nominal income by the price level expressed in hundredths

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Unanticipated inflation

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hurts fixed-income receivers, savers, and creditors because it lowers the real value of their assets.
Unanticipated inflation may not affect or may help flexible-income receivers

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cost-of-living adjustments (COLAs)

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helps debtors because it lowers the real value of debts to be repaid

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anticipated inflation

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people can adjust their nominal incomes to reflect the expected rise in the price level, and the redistribution of income and wealth is lessened

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Hyperinflation

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extremely high rates of inflation

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45-degree line

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on the graph would show where consumption would equal disposable income

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consumption schedule

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shows the amounts that households plan to spend for consumer goods at various levels of income, given a price level

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Break-even income

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where consumption is equal to disposable income.

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saving schedule

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indicates the amounts households plan to save at different income levels, given a price level

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average propensity to consume (APC)

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the percentages of income spent for consumption

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average propensity to save (APS)

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the percentages of income saved

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average propensity to consume (APC) and the average propensity to save (APS)

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they sum to 1

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marginal propensity to consume (MPC)

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the percentages of additional income spent for consumption

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marginal propensity to save (MPS)

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the percentages of additional income saved

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marginal propensity to consume (MPC) and the marginal propensity to save (MPS)

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they ALSO sum to 1

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wealth effect

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f household wealth increases, people will spend more because they think they have more assets from which to support current consumption possibilities

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paradox of thrift

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more saving helps household budgets and at the same time the decline in spending from more saving worsens the recession

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expected rate of return

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It is the marginal benefit of investment for a business

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real rate of interest

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the price paid for the use of money

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investment demand curve

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shows this inverse relationship between the real rate of interest and the level of spending for capital goods

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multiplier

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the ratio of the change in the real GDP to the initial change in spending

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aggregate demand–aggregate supply model

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explains why real domestic output and the price level fluctuate in the economy

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Aggregate demand

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a curve that shows the total quantity of goods and services (real output) that will be purchased (demanded) at different price levels

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Real-balances effect

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An increase in the price level decreases the purchasing power of financial assets with a fixed money value, and because those who own such assets are now poorer, they spend less for goods and services. A decrease in the price level has the opposite effect.

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Interest-rate effect

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ith the supply of money fixed, an increase in the price level increases the demand for money, increases interest rates, and as a result reduces those expenditures (by consumers and business firms) that are sensitive to increased interest rates. A decrease in the price level has the opposite effects.

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Foreign purchases effect

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An increase in the price level (relative to foreign price levels) will reduce U.S. exports, because U.S. products are now more expensive for foreigners, and expand U.S. imports, because foreign products are less expensive for U.S. consumers. As a consequence, net exports will decrease, which means there will be a decrease in the quantity of goods and services demanded in the U.S. economy as the price level rises. A decrease in the price level (relative to foreign price levels) will have opposite effects.

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determinants of aggregate demand

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Spending by domestic consumers, businesses, government, and foreign buyers that is independent of changes in the price level are

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Consumer spending

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can increase or decrease AD If the price level is constant, and consumers decide to spend more, then AD will increase; if consumers decide to spend less, then AD will decrease

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Investment spending

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can increase or decrease AD If the price level is constant, and businesses decide to spend more on investment, then AD will increase. If businesses decide to spend less on investment, then AD will decrease

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Government spending

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has a direct effect on AD, assuming that tax collections and interest rates do not change as a result of the spending.

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Net export spending

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can increase or decrease AD. If the price level is constant and net exports (exports minus imports) should increase, then AD will increase. If net exports are negative, then AD will decrease

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Aggregate supply

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is a curve that shows the total quantity of goods and services that will be produced (supplied) at different price levels. The shape of the aggregate supply curve will differ depending on the time horizon and how quickly input prices and output prices can change

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immediate short run

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the aggregate supply curve is horizontal because both input prices and output prices remain fixed

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short run

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the aggregate supply curve is up-sloping because input prices are fixed or highly inflexible and output prices are flexible, and thus changes in the price level increase or decrease the real profits of firms. The curve is relatively flat below the full-employment level of output because there is excess capacity and unemployed resources so per-unit production costs stay relatively constant as output expands, but beyond the full-employment level of output, per-unit production costs rise rapidly as output increases because resources are fully employed and efficiency falls.

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long run

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he aggregate supply curve is vertical at the full-employment level of output for the economy because both input prices and output prices are flexible. Any change in output prices is matched by a change in input prices, so there is no profit incentive for firms to produce more than is possible at full-employment output.

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determinants of aggregate supply

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changes in the prices of inputs for production, changes in productivity, and changes in the legal and institutional environment in the economy

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Domestic resource prices

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include the prices for labor, capital, and natural resources used for production

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price of imported resources

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the cost of paying for resources imported from other nations

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productivity

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output divided by input

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per-unit production costs

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which is: total input cost divided by productivity

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equilibrium real output and the equilibrium price level

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are at the intersection of the aggregate demand and the aggregate supply curves

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increase in aggregate demand

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would result in an increase in both real domestic output and the price level. An increase in the price level beyond the full-employment level of output is associated with demand-pull inflation

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decrease in aggregate demand

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educes real output and increases cyclical unemployment, but it may not decrease the price level. In 2008, there was a significant decline in investment spending that reduced aggregate demand and led to a fall in real output and a rise in cyclical unemployment

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disinflation

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rate of inflation fell

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efficiency wages

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maximize worker effort and morale, employers may be reluctant to lower wages because such changes reduce work effort and productivity

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price war

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compete with each other on lowering prices regardless of the cost of production

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menu costs

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input prices if there are costs related to changing the prices or announcing the change

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long-term contracts

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wages cannot be changed in the short run.

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efficiency wages

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maximize worker effort and morale, employers may be reluctant to lower wages because such changes reduce work effort and productivity.

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minimum wage

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puts a legal floor on the wages for the least-skilled workers in the economy

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decrease in aggregate supply

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there will be a decrease in real domestic output (economic growth) and employment along with a rise in the price level, or cost-push inflation

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increase in aggregate supply

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arising from an increase in productivity has the beneficial effects of improving real domestic output and employment while maintaining a stable price level